A factory gauge for February fell to a seven-month low, HSBC Holdings Plc and Markit Economics said yesterday. Barclays Plc said yesterday that the central bank had turned “more supportive” as the overnight loan rate sank to the lowest level in 10 months.

Investors are focused on financial stresses in the world’s second-biggest economy after the near-default last month of a high-yield trust product and as economists forecast the nation’s slowest expansion in 24 years. While the government has cooled credit growth, a record 2.58 trillion yuan ($425 billion) of new financing in January highlighted the challenges that remain.

“It’s relatively difficult to pursue two policy goals at the same time,” said Ding Shuang, the senior China economist with Citigroup in Hong Kong. “On the one hand, China needs to delever and on the other hand it needs to ensure a certain level of growth.”

Ding said that the government will move to support growth if a slowdown “challenges” its bottom line of a 7 percent expansion. Last year, the economy grew 7.7 percent.

The preliminary reading of 48.3 in the manufacturing index was less than the 49.5 median estimate in a Bloomberg News survey of economists. A number below 50 indicates contraction.

Yuan Tumbles

Asian stocks extended declines after the data yesterday, commodities fell and the yuan tumbled the most against the dollar in two years in offshore trading. The yuan sank 0.36 percent to 6.0652 per dollar as of 4:54 p.m. in Hong Kong, data compiled by Bloomberg show.

The country averted its first trust default in at least a decade last month with a bail-out of investors in a 3 billion-yuan high-yield product issued by China Credit Trust Co. and distributed by Industrial & Commercial Bank of China Ltd. In a monetary policy report this month, the central bank said it will strengthen supervision of wealth-management products.

“In the first half the economy will continue to slow down since the monetary conditions are tight,” said Zhang Zhiwei, Nomura Holdings Inc.’s Hong Kong-based chief China economist. “We think the economy will recover in the second half due to loosening of monetary policy in the second quarter.”

Reserve Requirements

Zhang predicted that the central bank will cut lenders’ reserve requirements by 50 basis points in the second quarter and another 50 in the third quarter, adding that “the credit supply will pick up as well.” Currently, China’s largest lenders must set aside 20 percent of their cash as reserves.

By contrast, JPMorgan Chase & Co. said that reserve requirements are likely to stay unchanged and “credit tapering will continue.” Societe Generale SA forecast “no major easing just yet” and said that the government may tolerate more of a slowdown.

According to calculations by UBS AG from central-bank data, China’s overall credit rose about 18 percent in January from a year earlier, slowing from growth of 18.4 percent in December. In 2009, when the government was driving stimulus spending to counter the effects of the global financial crisis, increases reached as much as 36 percent, according to UBS.

Lending Surge

In January of this year, new local-currency lending was 1.32 trillion yuan, the highest level since 2010, the People’s Bank of China said in a Feb. 15 statement. Trust loans, under scrutiny because of default risks, were about half the level of a year earlier.

“Beijing policy makers should and can fine-tune policy to keep growth at a steady pace in the coming year,” Qu Hongbin, HSBC’s chief China economist in Hong Kong, said in a statement yesterday.

Economic expansion will slide to 7.4 percent in 2014, according to the median forecast in a Bloomberg News survey.

The PMI number contrasts with better-than-forecast export and import numbers for January, leading some economists to caution that Chinese data in January and February are distorted by the weeklong Lunar New Year holiday, which began this year on Jan. 31 and last year on Feb. 9.

At Royal Bank of Scotland Group Plc in Hong Kong, economist Louis Kuijs said that the trade figures indicated that “many manufacturing companies pushed production and goods out in January, before an extended break in February.”

Banks’ non-performing loans rose by 28.5 billion yuan in the last quarter of 2013 to 592.1 billion yuan, the highest since September 2008, according to the China Banking Regulatory Commission. Still, bad loans accounted for only 1 percent of total lending, up from 0.97 percent three months earlier.

UBS economist Wang Tao, who forecasts a 7.8 percent economic expansion this year, says officials should allow trust and corporate bond defaults, while avoiding chain reactions.

“They should allow some defaults in a controlled and managed way to basically reduce moral hazard in the markets,” Wang said in Hong Kong. “People need to be aware that high returns are related to high risks.”

To contact Bloomberg News staff for this story: Rachel Butt in Hong Kong at rbutt4@bloomberg.net; Xin Zhou in Beijing at xzhou68@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

http://www.bloomberg.com/news/2014-02-19/chinese-manufacturing-index-slides-to-lowest-level-in-7-months.html

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